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This Halloween, investors should remember – fear is always the key

Emotion can play a huge part in investment and investment returns so, this Halloween – and every other day of the year – investors should remember that what they most have to fear is fear itself

31/10/2018

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

Halloween is the one time of year most financial commentators feel comfortable trying to put the wind up investors.

To be fair, we have been no exception in recent years, here on The Value Perspective – although, in defence of our position as serial contrarians, we should add we will also happily set out  to scare our readers rigid any other week of the year, should we feel it appropriate (as we increasingly seem to these days).

Given the recent market falls, of course, seeking to frighten investors does seem a bit redundant at the moment – although you might argue that is always the case as investors live in a perpetual state of fear. Yes, it is more usual to suggest they seesaw between the emotional extremes of fear and greed – but, in market terms, you could just as easily characterise the latter emotion as ‘fear of missing out’.

FOMO

To illustrate the point, let’s consider an investment model that, between 1987 and this year, would have turned £1 invested in the US’s main S&P 500 market into £43 – compared with £24 if you had just ‘bought and held’ – and would have reduced  the worst loss you would have seen over the period from 51% to 23%.

Interested? Surely most people would be – right up to the moment they understand the level of resolve it demands.

And no, we are not actually talking about a value-oriented investment strategy but one that involves even greater amounts of discipline from its adherents.

Tagged as “the best predictor of future stockmarket returns” by ‘Of Dollars and Data’ blogger Nick Maggiulli, it involves seeking to time buying and selling the market according to the average US investor’s allocation to equities.

If they are less than 50%-exposed, he suggests, you buy in and, if they are more than 70%-exposed, you switch to bonds.

“Anecdotally this idea makes sense,” he continues. “For example, Business Week’s ‘Death of Equities’ issue came out in 1979, the year before the best back-to-back decades in US stockmarket history, while the dotcom bubble was the point of maximum stock demand right before a decade of low returns.”

Now, to be clear, we are not advocating you follow this model.

Too painful to try

No, what interests us is Maggiulli’s assertion that you would not be able to do so – nobody would – because it is just too painful to try. If you had, he notes as an example, you would have had to sell all your equities in September 1996 and stayed in bonds all the way through to October 2002.

“Though it outperformed in the end,” he adds, “at what psychological cost?

“Can you imagine how hard it would be to sit in bonds for four years while your friends – some of them dumber than you – got rich along the way? It would be near impossible.

The same thing happened in the financial crisis when this model signalled to get out of stocks in May 2006 and get back in during November 2008. Yes, this also outperformed ‘Buy and hold’ over that period, but who could have waited it out?”

 Human emotion stands in the way

In both instances, it is fear of missing out that would have prevented almost anybody from selling up in the heady days of September 1996 and May 2006 – while fear of the more traditional variety would have kept most people from buying equities in the tough times of October 2002 and, worse still, November 2008, when global markets where enduring the very darkest days of the global financial crisis.

Here on The Value Perspective, we cannot help but be struck by some clear parallels with pursuing a value investment strategy.

That too sounds simple enough in theory – ‘buy cheaply-priced businesses’ – but turns out to be rather tougher in practice.

For one thing, there is the hard work value investors need to put in to ensure the businesses they buy are financially sound and it is only negative sentiment weighing against them.

And then of course there is the execution of the strategy, which involves overcoming a number of emotional biases and having the mental discipline to buy when others are fearful and sell when others are greedy (or fear missing out).

This is when value investors really make their money but, even when you are buoyed by the knowledge you have more than a century of data showing the strategy works in the long term, these can be lonely and painful times.

Is it for most investors? We fear not.

Please remember that past performance is not a guide to future performance and that any of the above strategies' performance may not be repeated. 

Author

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

I joined Schroders in 2015 as a member of the Value Investment team. Prior to joining Schroders I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst. 

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